Journal Article

Understanding the price puzzle

Abstract: Recent developments in measuring the stance of monetary policy have highlighted an interesting puzzle--namely, that an unexpected tightening in monetary policy leads to an increase rather than a decrease in the price level. In this article, Nathan Balke and Kenneth Emery present evidence on the price puzzle and discuss possible explanations for it. ; Balke and Emery find that the most plausible explanation is that, during the 1960s and '70s, monetary policy was not implemented in a way that fully offset inflationary supply shocks. During this period, monetary policy would tighten in response to a supply shock but not by enough to prevent inflation from rising. In the data, therefore, contractionary policy is positively correlated with inflation. Since the early 1980s, however, the price puzzle has disappeared for either one, or both, of two reasons: the Federal Reserve has placed greater emphasis on achieving price stability, or there have been fewer inflationary supply shocks to the economy.

Keywords: Prices;

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Economic and Financial Policy Review

Publication Date: 1994

Issue: Q IV

Pages: 15-26